Developing economies - Central Europe

 Useful material looking at interdependence, economic development etc. Some good context for essays:

ANALYSIS

Frederic Guirinec

The challenge for central Europe

PICTURESQUE POLAND HAS BECOME A MANUFACTURING POWERHOUSE

After years of being Europe’s fastest-growing region, the Visegrád Group’s economic model may be reaching its limit. But the region still offers rare value, says Frederic Guirinec

The Central European economies of Poland, the Czech Republic, Hungary and Slovakia – known as the Visegrád Group (see box) – have seen strong average annual growth of 5% since they joined the EU in 2004. The real GDP of the area has more than doubled over this time, driven by foreign investment in capital-intensive industrial production: in 2019, Poland was the leading destination for greenfield foreign direct investment (FDI) in the bloc, with $21.8bn (£17.4bn) invested, compared with $19.2bn in Germany and $15.7bn in France, according to fDi Intelligence.

However, this steady growth could soon be under threat due to dependence on western Europe’s capital and markets. The global economic recession may reveal structural issues with the region’s economic development and point to what must change if these countries want to become more than a destination for low-cost, high-quality manufacturing.

COPING WITH COVID-19

Central and eastern Europe have coped well with the pandemic. Governments had time to observe the spread in western Europe and learn from other countries, closing their borders early to significantly limit the pandemic. Now lockdowns are being lifted and activity is increasing steadily. Google’s Covid-19 community mobility reports indicate that life is returning to normal: by the end of June, retail and recreation mobility was back to pre-lockdown levels, especially in the Czech Republic (compared with 48% below normal in the UK) and transit and work mobility is crawling back up (-20% versus -50% in the UK). 

The Polish economy, which represents more than half of the GDP of this region, contracted by 0.5% during the first quarter – a better outcome than in most large European economies. The damage was obviously greater in the second quarter and overall the economy is forecast to contract by 4.6% in 2020, according to the IMF. This would be the first recession in Poland since 1994. Still, the government has designed a very large support programme worth PLN212bn (£42.5bn or 9% of GDP) and hence the country is likely to see one of the smallest peak-to-trough falls in GDP in Europe. The strong challenge that Warsaw’s mayor Rafal Trzaskowski posed to incumbent president Andrzej Duda in the presidential election was much more about social values than the government’s handling of the pandemic and its related economic impact (see politics & economics).

RELYING TOO MUCH ON THE NEIGHBOURS

The Achilles’ heel of central Europe is its dependence on Germany. The region is often seen as the German hinterland – it generates between 25% and 30% of trade with its larger neighbour. This means that in this crisis it will benefit indirectly from the massive economic stimulus in Germany, which amounts to €1.1trn (30% of German GDP) when including guaranteed loans. However, being so closely linked to one neighbouring economy raises the area’s vulnerability to external shocks and also risks restricting its long-term development too closely to what suits Germany’s needs.

The Visegrád economies offer skilled labour at much lower cost than western Europe. Despite a 35% increase since 2012, total labour costs in the manufacturing sector stand at €11 per hour on average, well below the average of €32 per hour in the eurozone, according to Rexecode, an economic research institute. That said, the declining supply of skilled labour is becoming a significant bottleneck. Since joining the EU, two million Poles have emigrated, forcing the country to rely on more low-skilled immigration from Ukraine. Indeed, Poland has welcomed a record number of migrants in recent years.

“THE ACHILLES’ HEEL OF CENTRAL EUROPE IS ITS DEPENDENCE ON GERMANY”

The vehicle industry is an outstanding example of the strengths and limitations of this growth model. These four countries produce 3.3 million cars a year, equivalent to British and French car production combined: car manufacturing represents 40% of Hungary’s exports. The factories are not simply assembly facilities that put together parts made elsewhere: large investments by firms such as Audi and BMW also ensure integration into the global supply chains of multinationals and contribute to technological transfer and an upgrade of physical infrastructure. But foreign ownership of these facilities means that key decisions are still made elsewhere. 

OPPORTUNITIES FOR INNOVATION

So the region needs to develop its research and development (R&D) capacity if it is to become more than a convenient location for manufacturers. Unfortunately, R&D spending remains very low in the region, at under 1% of GDP in Poland and Slovakia. Only the Czech Republic has achieved more, at 1.7% – in line with the UK, but well below Germany’s 2.9%. On the plus side, the Visegrád economies have avoided falling into what economists call the middle-income trap, where rising living standards and wages in fast-developing countries mean that they lose their competitive edge (low labour costs) without developing the skills needed to move up the value chain. Instead, the region can draw on a rich and robust industrial heritage that leaves it capable of innovation. Its advantages include a long tradition in education of technical universities and a multilingual workforce, similar to Switzerland and Germany.

The limited size of local economies encourages firms to roll out products and services to global markets quickly. Hence central Europe has become Europe’s fastest emerging start-up ecosystem, raising $1.8bn in 2019 compared with $1bn in 2018, according to PFR Ventures, a venture-capital investor backed by the Polish government. This has so far created eight unicorns (start-ups valued at more than $1bn), including GitLab, Grammarly, Bitfury and Bolt. With dynamic hubs such as The Heart and Google Campus Warsaw, Poland has been ranked as the seventh most-attractive country for start-ups globally by Ceoworld magazine – just behind Germany. This environment is drawing heavyweight foreign direct investment: Microsoft announced a $1bn investment in a new data centre in Poland, Google is planning a similar $2bn project and SK Innovation – part of one of South Korea’s largest business groups– is to invest €335m in producing components for lithium-ion batteries.

“STOCKMARKET VALUATIONS FOR THESE COUNTRIES ARE AMONG THE LOWEST IN THE WORLD”

The four countries may also be able to decrease their dependence on Germany if they integrate their economies more closely with each other. Trade within the region currently represents less than 60% of trade with Germany. However, since 1990 growth has been encouragingly inclusive: unemployment fell sharply and wages increased. So economic growth is increasingly driven by domestic demand as households benefit from these favourable trends in the labour market. The Visegrád economies are also coordinating more closely with their neighbours through the Three Seas Initiative (which includes 12 countries that link the Baltic Sea, the Adriatic Sea and the Black Sea), as well as pursuing major regional infrastructure upgrades such as a 1,800km link from Gdansk on the Polish coast via Vienna in Austria to Bologna in Italy.

CHEAP WHATEVER HAPPENS

Importantly, even if these economies do not evolve as much as they should, their stockmarkets are cheap enough to be compelling. Valuations are among some of the lowest in the world: the cyclically adjusted price/earnings (p/e) ratio (Cape – see page 15) for the Czech Republic is eight, Poland 8.5 and Hungary 12.5. Poland is the largest of the four and is the one that attracts the most attention from investors. CD Projekt is the current darling of its exchange: this video-game publisher has seen its share price rise 350% over the last three years following the huge success of The Witcher 3 and there are high hopes for its upcoming release Cyberpunk 2077. Last month, its market capitalisation passed that of Ubisoft, Europe’s biggest games firm. CD Projekt now looks pricey on a p/e of 154, but is an encouraging example of Poland’s ability to produce successful tech firms. A cheaper play in the IT sector is banking software provider Asseco Poland (Warsaw: ACP), on a p/e of 17.5. I first recommended this in MoneyWeek in 2017; its shares had failed to impress until recently, but have done better in the last few months.

The Czech electricity producer CEZ (Prague: CEZ) is one of the ten largest energy firms in Europe. It generates good cash flows and offers a decent dividend yield of 7% (6% net of dividend withholding tax). In Hungary, pharmaceutical firm Gedeon Richter (Budapest: RICHTER) enjoys a 17.8% operating margin and carries no net debt. London-listed regional drinks firm Stock Spirits (LSE: STCK) is performing well and remains relatively good value compared with multinationals such as Diageo or Pernod Ricard, on a p/e ratio of around 17.5. 

Fund investors should be aware that eastern Europe funds often include (and are dominated by) Russia, but the Amundi MSCI Eastern Europe ex Russia (Paris: CE9) is an exception. It has around 68% in Poland, 22% in Hungary and 10% in the Czech Republic. Poland is the only market large enough to have a dedicated ETF, iShares MSCI Poland (LSE: SPOL).

A brief history of the Visegrád Group

The Visegrád Group is an alliance of four central European states sharing common values and economic interests: Poland, the Czech Republic, Hungary and Slovakia. The group was created in Visegrád, Hungary, in 1991, to strengthen military, cultural, economic and energy cooperation among its members, including pursuing membership of Nato and the EU. The choice of name refers to the congress of Visegrád in 1335 between John I of Bohemia (in what is now the Czech Republic), Charles I of Hungary and Kazimierz III of Poland. Their main purpose was to settle the dispute over the Polish throne limiting the armed conflicts, encouraging diplomatic custom and to create new commercial routes to bypass the Habsburg empire in Vienna.

All four countries joined the EU at the same time in May 2004 and the region has since become a major economic centre. Together, the Visegrád Four have a population of 64 million inhabitants – similar to Italy, France or the UK – and a GDP of $2.13bn in purchasing power parity (PPP) terms (which accounts for differences in the cost of living), similar to the $2.24bn GDP of Italy.

All four countries have a PPP GDP per capita greater than Portugal and Greece. The figure for the Czech Republic, the wealthiest, is $40,585 according to IMF estimates, putting it broadly in line with Italy ($41,582). But GDP per capita at market exchange rates remains much lower, ranging from $14,900 for Poland to $23,200 for the Czech Republic, providing further room for catch-up growth.

Whether you are pro- or anti-Brexit you need analysis points:

 You all know my stance on Brexit; yes, this is a supportive article, and you do need both sides of every issue, so if someone wants to forward to me (or put on the wider reading record) an article highlighting all the downsides to no-deal I will gladly read it. Here are 3 points to use in any trade-related essay: Matthew Lynn

City columnist

No deal is the best deal for Britain – and the EU too

Europe has a lot to gain from a thriving, independent Britain

EVEN CENTRALISING EUROCRATS LIKE MICHEL BARNIER SHOULD SEE A NO-DEAL EXIT AS A WIN

With only three months left, and with the Covid-19 crisis still absorbing our leaders’ energies, the chances of a trade deal as our transitional agreement with the EU comes to an end seem more remote that ever. Britain appears to have reconciled itself to leaving without any kind of arrangement. Most of the EU is slowly coming to the same conclusion. The gulf between the two sides looks too wide to be bridged. The EU wants Britain to remain within its legal and regulatory control, while the UK wants to make its own laws, and set its own standards. Both sides would prefer not to do a deal than compromise on those principles. 

SOME MUCH NEEDED COMPETITION

That is reasonable. The British have rightly concluded that the cost of tariff-free access to the EU market is too high for the rather minimal benefits. Most of the tariffs are fairly minor, and can easily be absorbed by the exchange rate, and while there would be some benefits from eliminating them, that can more than be made up for by growing new industries free from European regulations. And, in truth, if it was thinking straight, the EU should see that it too has a lot to gain from a successful no-deal Brexit. 

First, the UK would provide some much needed regulatory competition. To listen to the centralising bureaucrats in Brussels you might imagine that a close neighbour with a slightly different regulatory, legal and tax system is a threat. It would lead to “social dumping” (code for “making things a little cheaper than the person next door does”), hand power to unchecked corporations, and undermine their labour and environmental standards. But that is not true. Competition is a good thing, and that is just as true of tax and regulation as it is of anything else. A free-market neighbour would be a check on the centralising ambitions of Brussels, and a model for innovation, which is just what the EU’s economy needs. It would make it slightly harder for eurozone governments to raise taxes and impose new rules, and it would force them to think harder about which ones worked and which didn’t. 

Second, a no-deal Brexit might well turn Britain into an offshore hub, with a deregulated, low-tax model. But would that really be such a terrible outcome? Much like Hong Kong for China, or Singapore for the rest of southeast Asia, a deregulated, freewheeling UK could funnel a lot of trade and investment into the rest of Europe while not being bound by its rules. Singapore and Hong Kong have done a lot to boost their whole regional economies. The UK could play the same role for the rest of Europe. 

Finally, surely it is in everyone’s interests for the UK to be as successful as possible after it leaves the EU. The UK is one of the largest markets for the rest of Europe, so the richer we are, the more we will import, which means EU companies will be able to grow more quickly as well. At the same time, with no deal, and with regulatory divergence, it is inevitable that some companies will have to move operations to different countries to stay within the EU and preserve full access to the single market. Those countries will gain some extra jobs that wouldn’t exist if there were a trade deal. 

Sure, there is a big downside to a successful no-deal outcome: it will show that leaving the EU can work. If the UK departs without any formal arrangement, and does so at least reasonably well, then it may well encourage a few other countries to wonder if they shouldn’t follow suit. To hardcore federalists in Brussels, that may be too high a price to pay, and they will remain determined that Brexit should be as catastrophic as possible. To everyone else, though, it should be clear that leaving without a deal should be hugely beneficial. The UK will be richer. It will be a conduit for investment into the rest of the EU. And it will discipline the EU’s mania for over-regulating and over-taxing its economy. The UK should start persuading the rest of Europe that an amicable no-deal exit is the best deal for both sides – and to concentrate on making an economic success of that

Japan in a nutshell - very good context

The mixed legacy of Shinzo Abe

SHINZO ABE: HIS REIGN HOLDS LESSONS FOR A STAGNATING WORLD

The long-serving Japanese prime minister is quitting due to bad health. That spooked markets, but his programme for economic revival looks likely to live on. Is that a good thing? Simon Wilson reports

WHAT HAS HAPPENED?

Japan’s longest-serving prime minister, Shinzo Abe, in power since late 2012, announced last Friday that he would be resigning on health grounds as soon as his party could elect a successor. During a brief first spell as PM in 2006/7 Abe was seen as a conservative nationalist. In his second lengthy spell, since 2012, he has been seen as relatively pragmatic. He has provided much needed political stability, improved relations with China as well as allies in Asia (with the notable exception of South Korea), sealed important trade deals, and pursued an economic policy – “Abenomics” – aimed at restoring growth and ending deflation. His decision to step down unnerved markets, although his successor is likely to adopt a very similar policy programme.

WHAT IS “ABENOMICS”?

It was the attempt, from 2013 onwards, to revitalise Japan’s long-sluggish and deflation-prone economy with a “three arrow” strategy of ultra-loose monetary policy, fiscal stimulus and structural reforms. The most long-lasting of these was the sustained programme of “quantitative and qualitative” easing by the Bank of Japan under its Abe-appointed governor, Haruhiko Kuroda (who will remain in post after Abe’s departure). By 2018, after a five-year bond-buying spree, Japan’s central bank had become the first among G7 nations (and only the second after Switzerland) to own assets worth more than the whole of the national economy.

WHAT ABOUT THE STRUCTURAL REFORMS?

One of the most common criticisms of Abe is that he never delivered on his promises of deep-seated structural reforms. “It is true he never did the most radical things, such as tearing up protections for salaried staff,” says the Financial Times. “But he did liberalise Japan’s electricity market, open the country to Chinese tourists, cripple the agriculture lobby and sign two huge trade deals.” Labour-market reforms aimed at attracting more women into the workplace have been modestly successful. And Abe also introduced important corporate governance reforms, combined with a new stewardship code, that have made Japanese investments far more attractive to foreign and institutional investors. From 2017-19, Japan attracted more private-equity investments than any other country, and its level of M&A activities is second only to the US. 

“IN THE WAKE OF COVID-19, ABE WEIGHED IN WITH A STIMULUS PACKAGE WORTH 40% OF GDP”

DID ABENOMICS PROVE A SUCCESS?

Yes and no. Kuroda’s market-pleasing policy of ultra-low interest rates and bond-buying drove a rally in stocks and sent the yen lower, boosting exporters, and helping to keep growth in positive territory. Inflation picked up a little, meaning officials could declare that the long era of deflation was over. Corporate profits rose, and unemployment remained low, but in spite of Abe’s repeated urgings, those profits never fed through into wage inflation sufficiently strongly to drive a sustained boost to consumer spending. Inflation remained stubbornly below the central bank’s 2% target. Thus, on its own terms, Abenomics failed. Most notably, the anti-growth effects of raising the consumption tax from 5% to 10% outweighed the stimulus effect of great government spending. Yet under Abe both growth and employment improved, partly due to the weaker yen. And there has been no debt crisis, despite the persistent warnings of Abe’s critics (including the deficit hawks within his own party). 

WHAT ELSE DID HE ACHIEVE?

Abe’s efforts benefited from propitious timing, says Ben Dooley in The New York Times. In particular, China’s economy surged during his tenure, boosting its appetite for Japanese machine tools and the specialised components needed to manufacture things such as cars and high-end electronics. In addition, Chinese tourists, “eager to spend their growing wages, flooded Japan’s cities and tourist sites, splashing out on luxury goods”. By late last year, however, Japan’s economy was contracting due to slowing global trade and the brewing trade war between the US and China, which badly hit Japanese exports. With Japanese national debt at 150% of its GDP (the highest proportion of any developed economy), Abe once again turned to a rise in the consumption tax in the hope of tackling the debt and shoring up social programmes. The tax rise killed off spending, and then a vicious typhoon devastated central Japan, compounding the economic damage. By the time the Covid-19 pandemic took hold, Japan was already in recession.

SO ABE LEAVES ON A BAD NOTE?

Indeed. Japan’s GDP fell by an annualised 28% in the second quarter, and Abe’s government weighed in with a stimulus package worth an astonishing 40% of GDP, including low interest loans and cash grants. Covid aside, Abenomics will be remembered for growing the economy, creating jobs and keeping deflation at bay, says Kathy Matsui, vice-chair of Goldman Sachs Japan. The question now is will Abe’s successor be able to tackle the remaining reform agenda items and bring Japan “once and for all out of deflation”, says Matsui. For the rest of the world – a world struggling with a slide towards stagnation, deflation and ultra-low interest rates — Abenomics offers “powerful lessons”, says Robin Harding in the Financial Times.

WHAT ARE THEY?

The key lesson is that “monetary policy works”; the initial “bazooka” of massive asset purchases in 2013 was highly effective. “Bond yields fell; stockmarkets boomed; and most important, the yen fell below ¥100 to the dollar, a boon to Japanese industry.” Another is that “weak economies cannot handle tax hikes” and economic strength  is a precondition for fiscal tightening.  Abe went off course when the consumption tax rose from 5% to 8% in 2014, ultimately pushing Japan back into recession.  “If you promise stimulus, and deliver restraint, you get failure,” says Harding. “That is the story of Abenomics in brief.”

Oxbridge candidates see what you can make of this piece on MMT

 

This will challenge you, but it is a very good example of the way economists redefine concepts in order to explain the true impact of something. It also has extension material to impress examiners (and interviewers), such as Ricardian Equivalence.

It will not be easy to understand at first, but see how far you can get.

MMT's Very Odd Definition of "Savings"

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TAGS Monetary PolicyInterventionismOther Schools of Thought

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07/30/2020Robert Blumen

Modern monetary theory, which is now experiencing its fifteen minutes of fame, contains a number of strange and counterintuitive propositions.1 Proponents claim that these propositions are not an economic theory, only an accounting identity. One of these is that the private sector can save only if the government runs a deficit. Within the self-consistent, tail-chasing world of MMT, these statements are true by definition. However, when MMT aphorisms are interpreted using their normal meaning in the English language, their conclusions are not only false, but foolish.

MMT defines savings as the accumulation of non–private sector assets. It must be the case that all liabilities between private sector actors net out to zero. And from that, the only way that the private sector can have a positive net credit is if something outside of it has a negative net. That something is the government (perhaps, but probably not so, as I will argue later).

The Definition of Saving

A good definition enables people to have a conversation about a topic by establishing a shared meaning. While anyone is free to define “up” to mean down and vice versa, Humpty Dumpty notwithstanding, a good definition, to avoid confusion, should be consistent with normal usage. In normal English, savings consist of what is produced and not consumed. I will show that using this definition it is possible for the private sector to save without a government deficit.

The first and simplest form of savings is saved consumption goods. Long duration goods such as homes, cars, appliances, clothing, and furniture are produced and then release their services over time. The US private sector has about $33 trillion of residential real estate, which consists of saved real estate services in the form of homes that will be used up over decades. Shorter duration consumption goods can also be saved, such as frozen food or tinned sardines, extra tubes of toothpaste, and in the days of the virus we must not underestimate the importance of saved toilet paper. Businesses also have saved inventories of consumption goods which they plan to sell in the near future.

The Role of Saved Capital Goods

The second and more important form of savings is saved capital goods. These are productive assets which, in the exact same way as saved consumer goods, have been produced but not consumed. According to the Fed, the United States has $56 trillion of saved capital goods. Some of that might be owned by governments, but even a fraction of the value held in private hands is an enormous amount. The importance of capital goods is that they are needed in order to produce consumption goods. Labor productivity depends on the amount of capital that workers have, which drives real wages. The gradual increase in our standard of living over the centuries is attributable to the quantity and quality of saved capital goods.

Even the Robinson Crusoe stranded on an island may save consumption goods such as caught and dried fish, harvested and stored coconuts and tubers. Crusoe may also save capital goods—such as a fishing rod, a net, or a ladder to harvest coconuts from trees—by creating them faster than they wear out.

Savings and Cash Balances

Another common usage of the term "savings" is cash balances. While MMT correctly points out that one person’s spending is another’s income, and therefore nets out to zero, the private sector cannot accumulate a net cash balance unless there are money flows in and out of it. In a gold monetary system, the private sector could accumulate cash through mining. But assuming for the moment that there are no cash flows between the private and government sector, and no money creation, the private sector cannot net accumulated cash. However, the private sector can increase its real cash balance through lower prices. This happens when the public preference for cash relative to goods changes in the cash direction.

The Problem with the MMT Definition of Savings

At this point we can see the main problem with MMT’s definition of savings as net government debt. Assets can be divided into two broad categories: debt and equity (equity being what you own and debt being what is owed). Every debt has two sides: the creditor, for whom it is an asset, and the debtor, for whom it is a liability. Net debt must balance to zero if you include both sides in your aggregate. Equity, being unencumbered, and having only one side, is a positive value, and can grow. An increase in one person’s equity in the form of saved capital or consumer goods does not require an offsetting debit anywhere else. To see this, consider Robinson on his ancap island, busily drying fish and storing coconuts. His gross equity increases on a daily basis without any offsetting liability anywhere in the South Pacific. MMT’s definition is incomplete, because it looks only at the debt component of assets while ignoring the equity.

Private sector net debt is always zero by definition. This truism tells us nothing interesting about the world and is only another way of stating the definition of debt. Private sector gross assets in the form of saved capital and consumer goods are the foundation of our economic well-being and are therefore quite important. Contrary to MMT, the proper object of study should be gross savings rather than net savings. Net assets in the form of external debts to foreign countries are not uninteresting for some purposes, but must be paid for out of either current or future production, which depends on the gross savings.

Now I will return to the issue of whether the private sector’s net position in the government debt market is truly an asset. Government debt could in theory be paid by selling government assets (and in some cases they have done so) but in most cases, government debt represents a claim on the taxing power of the government in question. And the tax liability is to a large extent owed by the same private sector that owns the bonds. Every increase in government debt imposes a future tax liability of the same amount on the same private sector. If we disaggregate down to the individual or household, some individuals owe more in tax than they own in government bonds, and others the opposite. While I am not a believer in Ricardian equivalence, the net positive asset position of the private sector in government bonds is offset by an equal tax liability on the aggregate level.

Many parts of MMT depend on the issuer of debt also being the monetary sovereign—the body that can create money out of nothing. It should be noted that this particular issue does not apply only to the issuer of government money. As long as the definition of the private sector excludes all governments of any level who borrow in the bond market, the same accounting identity applies. State and municipal governments could create MMT savings by borrowing. MMT might dispute my point about sovereign debt imposing a tax liability on the private sector on the grounds that the monetary sovereign can print and spend money into existence “for free” (i.e., without imposing any cost on the rest of society). I will not address that point here, but Robert Murphy has elsewhere.

Capital goods and consumer goods can be accumulated without any requirement in an accounting sense for obligations between the government and the private sector. If the government had no debt, it would enable the private sector to accumulate even more savings, because it would be freed of the tax liability.

You can define the word “savings” to mean anything you want. MMT savings defined as net government debt holdings enables the MMT tautology that the private sector cannot MMT save without the government running a deficit. However, this does not tell us anything useful. If anything, MMT saving should be discouraged, because the government drains resources from the domain of economic calculation and private property to socialism and government control. The focus should be on economic policies that enable private individuals and business firms to accumulate gross savings in order to improve our well-being.

Will we have a V-shaped recovery - optimistic view

DAVID SMITH

A strong bounce so far – but can it survive the autumn?

David Smith

Sunday August 30 2020, 12.01am, The Sunday Times

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We are entering a critical period for the economy. Tuesday marks the start of meteorological autumn, and the autumn will bring a series of challenges for the economy.

Will most children go back to school, thus freeing parents to return to the workplace? What will be the unemployment fallout of the ending of the furlough scheme, which Rishi Sunak is under growing pressure to extend? And is a government that wings it on most things prepared to wing it towards a no-deal Brexit, piling uncertainty and disruption on a fragile economy?

I shall keep that list of questions as an aide-memoire as we move through the coming weeks. In the meantime, Tuesday also marks the start of the final month of the third quarter, a three-month period that is crucial for the economy’s path out of the crisis.

Some readers got quite agitated a few months ago when I first suggested that this recession and recovery would have a “V” shape. They pointed to the lasting impact of Covid-19 on the way we live, work and spend. Indeed, to some it is strange to be talking about a recovery at all when city centres are deserted and commuter station car parks (including mine) have lots of empty spaces.

The answer is that people can still be working productively, and they are, even if they are not occupying city centre offices. However, the change in working patterns is severely damaging businesses that rely on commuters, the same way that public transport is being damaged.

The idea of the V was straightforward and logical. When the economy was in maximum lockdown, economic activity would be most severely curtailed, naturally picking up as lockdown measures were eased. It was more logical than an L — the economy drops sharply and stagnates at the lower level — or a U, a prolonged period of bumping along the bottom before a recovery.

The beginnings of a V were seen in the monthly gross domestic product (GDP) data for the second quarter. These and other data led Andy Haldane, the Bank of England’s chief economist, to declare his confidence in a V-shaped recovery. Politicians, including the chancellor, are understandably reluctant to join in with such talk, given that a rise in unemployment and further business failures look inevitable and that GDP does not mean much to most people.

So what are the prospects for this quarter? David Owen, European economist at Jefferies International, an investment bank, has been monitoring the downturn and upturn since the crisis began, with his economic activity radar.

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His latest readings show two things. One is that recovery is continuing. Electricity consumption has risen to 98% of normal levels, while traffic congestion is at 95%. Flights are increasing, albeit from a low base. Public transport is flat. Web searches of car dealerships are 14% above normal, while visits to property portals are 46% above normal, supporting the housing mini-boom story described here last week.

The evidence of a continuing recovery in these economic activity measures is enough to persuade Owen that there will be a 15%-plus rise in GDP in the current quarter, which would be good. We should take note of this. Very early on, his economic activity radar persuaded Owen that there would be a 20% fall in GDP in the second quarter, after which the Office for Budget Responsibility predicted a 35% fall, and the Bank of England a drop of 25%. The fall was 20%, so top marks to him for that prediction.

The other significant thing about these measures of economic activity is that they suggest that the UK’s recovery, which was lagging behind others, is now roughly on a par with those of Europe and America. There has been some evidence in Europe of an easing back in the pace of recovery.

There is other evidence of recovery. Barclays’ recovery tracker, which is largely based on spending trends, found that overall consumer spending in the middle of August was a hefty 10% up on a year earlier. There is more physical spending and less online spending, it suggested, and Sunak’s Eat Out to Help Out scheme has led to a significant increase in trade for restaurants, cafés and hotels. Its overall tracker is running at an impressive 98% of normal.

Domestic spending may have been boosted by the fact that many fewer people have been travelling abroad for holidays this summer, although the UK has lost the spending of foreign tourists. One interesting question is whether private versions of Eat Out to Help Out, introduced by some restaurant groups, can maintain the spending momentum.

Finally, the Office for National Statistics has its own coronavirus economic indicators. The latest of these showed that footfall at retail parks in the week beginning August 17 increased to 90% of year-ago levels, while shopping centre footfall was at just under 70% of last year’s levels.

Motor vehicle traffic was at 94% of pre-lockdown levels, while the issuance of energy performance certificates, a vital component in home buying and selling, rose to 83% of normal, adding support to evidence of a housing recovery. There has also been a sharp upturn in company formations: this month they have been running at 3,393 incorporations per working day, up from 2,612 a year ago. It could be that a lot of phoenixes are rising from the ashes.

All this bodes well for a strong growth number in the third quarter. But there is a sting in the tail of the ONS’s release: it is that 13% of the workforce is still furloughed this month, according to its survey of the business impact of the virus. Most workers (70%) are having furloughed pay topped up by employers, which suggests to me that these firms are not using the job retention scheme as a pathway to redundancies.

However, that 13% figure is significant. At face value, given that there are 28 million workers in employment (not including the self-employed), it suggests something like 3.6 million on furlough.

Those furloughed employees not finding their way back to work are one of the risks to recovery, together with the other questions I raised at the start of this piece. I don’t think this V will turn into a W, but the risks cannot be denied.

Politics and economics - discuss this with your parents

 

Sunak is bluffing: the Tories have no intention of paying back our Covid debts

The politics of reducing the gaping hole in the nation’s finances are 
toxic to the Conservatives

JULIET SAMUEL4 September 2020 • 8:00pm

Each spike on the chart tells of some catastrophe. The first one is World War One. The second, World War Two. The next big one is the 2008 financial crisis. The latest: Covid-19.

The spikes represent big rises in deficit spending. Afterwards, comes the retrenchment. Spending falls back down, but never by quite as much as it rose. Instead, tax revenues rise to plug the gap.

This time around, Rishi Sunak or his officials are supposedly hoping to make a head-start. There will be no tax “horror show”, the chancellor’s notes said as he was snapped leaving No 10, but there will be a little Halloween fright or, as he put it, a “plan to correct our public finances”. You’ve all enjoyed the performance by nice Rishi. Now get ready for scary Rishi!

Am I the only one entirely unmoved by this pantomime? The Government filled last weekend’s newspapers with chilling tales of a massive “tax raid” on corporations, capital gains, drivers and inheritance. That Covid bonanza has to be paid back sometime, tuts the Treasury. Well, yes, but Mr Sunak is just not a credible Scrooge. In truth, the Tories have no real intention of repairing the public finances this side of an election and unless bond markets turn nasty, they will get away with it.

The biggest reason is that Boris Johnson doesn’t believe in raising taxes. Every instinct in him rebels against the idea. Nor does it make any political sense. It would be economic madness to raise them now, before the Covid recession is over, and electoral madness to raise them later, when the next election creeps onto the horizon. As we saw in last year’s election, the Prime Minister also doesn’t believe that “austerity” is politically viable, even if he were the penny-pinching sort. So there is only one course left: keep spending and rely on the Bank of England to finance it.

This doesn’t mean, however, that the deficit is going to stay quite as high as it is today. At some point, the most acute emergency support – furlough and self-employment cash – will be withdrawn, although this may not happen in October as Mr Sunak claims. We won’t stay at the top of the spike for long. But the big, fat debt hangover it leaves behind is here to stay until the economy achieves some sort of new growth miracle or a Labour government arrives to whack up income and inheritance tax.

To understand why, it’s only necessary to look at the politics of all the alternative options. The public is sick of spending restraint and, with the exception of foreign aid, voters will not forgive any major new cuts to departmental spending. There are capital projects the Government could kill, like HS2 or hospital improvements, but such spending forms the core of Mr Johnson’s “levelling up” message and without them he hasn’t got much of a story to tell.

That leaves tax rises. The Tory manifesto effectively ruled out any big increases by promising not to touch income tax, national insurance and VAT, the Treasury’s three biggest earners. That leaves corporation tax, a levy easily avoided by multinationals which only accounts for about 8 per cent of revenues. There is inheritance, a toxic zone for Tory governments and a tax that is not currently used to raise significant revenues in any OECD country. There are a host of other little taxes, like tariffs, road tax and so on, 
all far more controversial than they are lucrative. There are property and capital taxes, which sound juicy, but likewise amount to peanuts in fiscal terms.

That brings us back to the manifesto. If Mr Sunak really wanted to tackle the national debt without spending cuts or new wealth taxes, he would have to rip up that manifesto pledge. But even here the Tories would run into problems. VAT is known to be inherently regressive, hitting the poorest hardest, and the Government currently wants to encourage more spending, not less.

Yet raising income tax also poses serious problems. Despite what many would have you believe, the UK already has one of the most progressive tax systems in Europe. It may be true that we tax our top earners somewhat less than our peers. Looking at income plus national insurance rates, they pay on average 51 per cent, versus 55 per cent across nine other Western European countries examined by the Institute for Fiscal Studies. But the really big difference is lower down the income chain. In the UK, the average tax rate for median earners is 28 per cent. Across the other nine countries, the equivalent figure is 44 per cent. When people say that the UK is lightly taxed compared to our peers, they usually gloss over this point. The group we tax least compared to our peers is not the top, but the middle.

Of course, it may none the less still be possible to extract more from the richest. But it seems rather likely that the biggest fiscal fix would come from increasing taxes on the lower-middle classes. Try putting that on an election billboard.

This is why it is essentially impossible for the Tories to fill in the big, fiscal black hole they have dug. The majority they won last year – their first in 30 years – relies on a coalition of affluent suburbanites and the patriotic working class. Between them, they cover all the constituencies that would be hit by taxing property, middle incomes and spending.

Meanwhile, so long as the most extreme Covid spending is wound down by the middle of next year, it looks unlikely that markets will turn up the pressure. Quite the opposite, in fact: most economists are fretting that governments will stop spending too soon, not too late. The biggest risk, therefore, is that we run into a big inflation shock in the next two years that sends investors running for the hills. That is a risk that the Tories are clearly willing to take.

After World War Two, Britain’s national debt hit an all-time peak of 250 per cent of GDP. It was not the Conservatives who paid it down, but the combined effect of explosive GDP growth and a frenzy of massive wealth and income tax rises imposed by a Labour government. Mr Sunak might wag his finger and fiddle around at the margins, but while Boris is in charge, the big debt hole is here to stay. For the country’s sake, we’d better hope no one calls his bluff.